1. When building a portfolio, you basically have two
choices.
With the availability of index funds, it’s not difficult to
build a portfolio. The question is, what kind of portfolio do you want to
build? Or, to put it another way, what are you trying to accomplish?
Do you want to trail the market when it’s going up or when
it’s going down?
You can structure your portfolio to be more aggressive than
the overall stock market. That will help you when the market is going up but
hurt you in down markets. Alternatively, you can structure things to be more
conservative than the market, in which case you’ll trail in up markets but lose
less when the market is going down. The takeaway being you can’t have it both
ways.
Investment returns (in the realm of normal) are within our
control. Many people worry about the stock market. It doesn’t need to be that
way. If you don’t want to lose sleep worrying about the market, you don’t have
to. It’s all about the asset allocation choices you make.
2. When it comes to investments, there’s no such thing as
perfect.
No investment is going to be perfect, and we shouldn’t
expect it to be. In traditional finance textbooks, investment decisions are
presented as a tradeoff between risk and return. If you want more
return, you must take more risk. But if you want less risk, you must be content
with lower returns.
That is a bit over-simplistic so when evaluating
investments, investors should think things through much more carefully. In
addition to risk and return, consider an investment’s fees, complexity,
liquidity, tax treatment and the overall level of economic certainty or
uncertainty.
3. When warranted, be willing to pay more.
It’s worth paying more if you’re getting extra value.
Most investors are sensitive to fees and taxes—and they should be—but this
comment is a good reminder not to take this too far.
Similarly, if you own an overpriced, underperforming fund,
should you hang on forever just because you would have to pay some taxes if you
sold? Of course not. Do the math and don’t
be afraid of costs if you think it will pay off in the long run.
4. Don’t fall in love with an investment.
Just as there’s no perfect investment, there is no
investment that you should expect to remain perfect for all
time. I see this as particularly applicable to thinking about index funds—an
investment that appears awfully close to perfect right now.
I believe that low-cost index and factor funds are the best
way to invest—and there’s plenty of supporting data. But we should
never be too comfortable. Currently, indexing works exceptionally well. But it
may not work forever. Markets are dynamic. Indexing might begin to work less
well or other forms of investing might begin to work better. Anything can
happen, so be careful. When it comes to your investments, you don’t want to be
blindsided.
CBlakely, CFP®, CTFA
